Tuesday, May 15, 2012

The House of Morgan

For those who don't follow massive financial disasters like I do, the recent news that J.P. Morgan has just lost a massive amount of money probably isn't all that surprising. What is surprising is the reaction--or, at least, some of it.

While chief investment officer has mysteriously "retired," both the Justice Department and the Securities and Exchange Commission have launched investigations as to what, exactly, happened, without going into a whole lot of detail as to what they were looking for. It's early yet, of course, but that doesn't sound particularly good.

Right off the bat, let's get this straight--it's entirely possible that something criminal has gone on, or at the very least financial regulations have not been followed properly. In fact, in any complex financial transaction, there are always regulatory issues; not because big bankers are greedy or sloppy, but because the regulations are so complicated and worryingly elastic that some government official is bound to find something wrong.So no matter what, some obnoxious official is going to hold up a sheet of paper with "evidence" of wrongdoing, even if such evidence is not particularly compelling. All the people want to hear is that a fat cat got smoked at his own game.

Here's the problem: big banks exist because they have the leverage to take big risks. Everyone involved would love it if financiers made money all the time, but if that were the case anyone could do it. Part of the "game" of finance is that there is some level of risk involved, and that's how profits are made.

Of course, this isn't the same as, say, gambling or chance. While there are certainly factors outside of one's control that could affect success, that's part of the information-gathering process. If there is a chance that a cold snap could destroy the coffee crop, that should be factored into whether one should invest in, say, Starbucks or Dunkin' Donuts. You've got a hunch that the Nook might do better than expected than the Kindle, but all of the bits of information--which may seem random to some--are collected in the grand total of "the market" and come up with a premium to pay over what the Nook or the Kindle would normally be The firm or individual who can best assess this information, and take the most prudent calculated risks, is the one who ends up rich.

The $2 Billion-with-a-B loss by J.P. Morgan is not good news for the economy. But failures are just as important as successes in the free market, and not every complete loss is cause for a government investigation.